Introduction

On 28 January 2022, the Securities and Futures Commission (the “SFC”) and the Hong Kong Monetary Authority (the “HKMA”) published a joint circular on intermediaries’ virtual asset-related activities (“VA-related activities”) (the “Circular”) to address the rising enquiries about distributing virtual asset-related products (“VA-related products”). The Circular focuses on the distribution of VA-related products, the provision of virtual asset dealing services (“VA dealing services”), and the provision of virtual asset advisory services (“VA-advisory services”). It is the latest circular that intermediaries should refer to when conducting VA-related activities.

Distribution of VA-related products

Selling restrictions

VA-related products can consist of complex products, which are subject to SFC’s requirements governing the sale of complex products. For example, virtual asset exchange-traded funds and exchange-traded products are likely subject to higher risks, which require additional restrictions to be imposed in order to protect investors. On the one hand, the Circular reinforces the position that only professional investors can be offered VA-related products which are considered complex products. On the other hand, intermediaries should conduct a virtual asset-knowledge test on their clients unless the client is an institutional professional investor or a qualified corporate professional investor. If the client’s knowledge is inadequate, a transaction in VA-related product can proceed only if it is in the client’s best interest, and the intermediary must provide the client with relevant training. However, intermediaries may offer to retail investors certain VA-related derivative products traded on regulated exchanges specified by the SFC.

Other relevant restrictions include Part IV of the Securities and Futures Ordinance (Cap. 571), which provides that investments offered to the Hong Kong public must be authorised by the SFC. The Circular also reminds intermediaries the importance of strict adherence to all selling restrictions when distributing VA-related products online.

Suitability obligations

Intermediaries should ensure that:

• recommendations or solicitations are suitable for clients in all circumstances;
• paragraphs 5.1A and 5.3 of the Code of Conduct for Persons Licensed by or Registered with the SFC are complied with, if the VA-related product is a derivative product; and
• proper due diligence on the products are conducted.

The Circular reminds intermediaries to be cautious in providing clients with financial accommodation for investing in VA-related products. They should explain VA-related products and the underlying virtual asset investments to clients in a clear and easily comprehensible manner as well as provide warning statements specific to virtual assets.

Provision of VA dealing services

The majority of VA trading platforms in Hong Kong are unregulated and even if they are regulated, it is only for the purposes of anti-money laundering (“AML”) and combating the financing of terrorism (“CFT”). According to the SFC’s regulatory framework on VA trading platforms published in November 2019, it imposes certain requirements on the key areas in order to protect the investors in Hong Kong. Some of the requirements are as follows:

• custody of client assets;
• know-your-client;
• AML and CFT;
• prevention of market manipulation;
• admission of virtual assets for trading;
• cybersecurity; and
• risk management.

However, the abovementioned measures are insufficient in protecting investors and investors may suffer substantial losses without recourse. As such, the SFC and the HKMA also consider that it is appropriate to require intermediaries to only partner with SFC-licensed VA trading platforms by introducing clients to the platforms for direct trading or establishing an omnibus account with the platform.

Furthermore, it is proposed that only intermediaries registered to conduct Type 1 regulated activity (i.e. dealing in securities) will be allowed to provide VA Dealing Services to their existing clients and are required to comply with all the applicable regulatory requirements, regardless of whether the virtual assets involved are securities.

Provision of VA-advisory services

It is proposed by the SFC and the HKMA that intermediaries are expected to comply with all the regulatory requirements when providing advisory services, not limited to the nature of the virtual assets. In addition, such services should only be provided to the existing clients of the intermediaries in Type 1 or Type 4 regulated activities (i.e. advising on securities). Moreover, it is proposed that if an intermediary provides advisory services in relation to virtual asset-related products, it should comply with the same requirements as those applicable to the distribution of virtual asset-related products.

Conclusion

The SFC and the HKMA have agreed to allow a six-month transition period before the full implementation of the expected requirements. As to intermediaries that do not currently engage in virtual asset-related activities, they should ensure that they are able to comply with the requirements before introducing any virtual asset-related activities. In addition, every potential intermediary is required to notify the SFC and the HKMA before engaging in virtual asset-related activities.